Goldman: EM currencies in for another drubbing

A dovish statement from the U.S. Federal Reserve on Wednesday is but a small setback for the U.S. dollar, with the greenback set to extend its rally against emerging market currencies, according to Goldman Sachs.

"Federal Reserve dovishness may provide some near-term respite, but on a 12-month basis we think that some of the factors arguing for EM currency weakness, such as current account imbalances, commodity price weakness and low inflation, are still present in varying degrees," Goldman Sachs said in a note published on Friday.

The U.S. dollar weakened broadly on Wednesday after Fed Chair Janet Yellen's more-dovish-than-expected comments tempered expectations for a rate hike as early as June. But the greenback quickly recovered in the following session as investors digested the news.

The dollar index is up around 9 percent year to date after rising nearly 13 percent last year amid speculation that a recovery in the U.S. economy would lead the Fed to raise rates.

"The U.S. dollar is in a cyclical bull market," said ANZ senior FX strategist Sam Tuck over the phone. Capital is flowing into the dollar because "the U.S. economy is relatively strong, and interest rates are set to rise and remain higher than anywhere else in the developed world."

Perfect storm

The need to adjust to lower oil prices, slowing global growth and the euro's recent tumble against the dollar, will continue to pressure emerging market currencies, analysts say.

For producer countries such as South Africa and Brazil, which are running wide current account deficits, currency depreciation is "an important channel of adjustment," according to Goldman.

Goldman expects the South African rand to weaken by around 10 percent over the next year, from 12.24 rand per dollar to 13.50 rand.

It tips the Brazilian real, which has plunged nearly 25 percent since the beginning of the year, is expected to fall another 4.2 percent to 3.45 real per dollar in a year's time.

On the other hand, for oil importers such as South Korea, currency depreciation is "a tool in the battle against very low rates of inflation," it said.

Goldman expects the Korean won to weaken by over 7 percent next year over the next 12 months to 1,120 per dollar – the most among Asian currencies. The won is down 3.16 percent so far this year.

Dovish overload

Given the frail outlook for global growth, analysts say central banks will remain under pressure to remain accommodative, which could extend the global easing cycle that has seen some 24 central banks cut rates this year.

"If EM central banks respond to the Fed's dovishness by dovish actions themselves, this could support EM bonds but would erode support for EM currencies over the medium term," said Goldman.

And the euro's weakness following the European Central Bank's massive quantitative easing program will only pile further pressure on EM currencies because they don't look so cheap anymore, the bank said.

The euro has weakened by 12 percent against the dollar this year and is trading at $1.0765; Goldman expects the euro will slide to $0.95 in a year's time and to $0.85 by end-2016.

"Linked to our expectation of more euro/dollar downside," more weakness will be seen, particularly in central and eastern European currencies, Goldman said.

The Hungarian forint is the most vulnerable, it said, tipping a 7.6 percent decline against the euro over the next 12 months.